M&A Roundtable: Supply Chain Risk and the Impact on Portfolio Companies

Jonathan Gilbert (00:10):
Well, thank you all for joining us here today for another episode of the Alliant M&A Podcast Roundtable. Today we are joined by Tim Conlon, a senior member of the M&A group based in San Francisco, as well as Jon Van Tuin from P4G Capital. So, very excited to hear from Jon at P4G Capital and his insights on the M&A market generally, as well as some of the, you know, great things that are going on at P4G Capital and some of the opportunities for, you know, private equity firms in today's economy. It's very interesting to get perspectives from the guys that are actually living this day-to-day. And so, we hope you all here today enjoy our time with Jon.

Tim Conlon (00:50):
Yeah, thanks Jon, appreciate it. I'd like to welcome Jon Van Tuin from P4G Capital. Jon and I are both primarily West coast based, San Francisco based. Jon's a 25-plus-year career private equity veteran. We welcome Jon and look forward to the discussion.

Jon Van Tuin (01:06):
Yeah, thanks, Tim. It's great. You know, looking forward to a lot of topics that we're going to discuss. We're kind of on the front burner here given kind of all the things that are going on, at least from a macro perspective. So again, thank you and look forward to it.

Jonathan Gilbert (01:21):
Absolutely. Well, thanks Jon, and we're excited to have you again. And maybe we'll start by - just tell us a little about P4G capital and what makes you guys a little unique as well as some of your recent growth. It looks like you've added a lot of people this year and I’m curious what you're gearing up for.

Jon Van Tuin (01:37):
I do think we're a little bit differentiated, or I like to think so, from other private equity groups out there. The background of P4G, the group was started actually back in 2015 by our founder Rachel Lehman, who previously was another co-founder of another private equity fund called Sorenson Capital. Was there for quite some time, had a lot of success and ended up leaving Sorenson Capital in 2015 to form P4G with the backing of some institutional investors. But outside of a committed fund, was able to kind of execute on a handful of deals under that kind of model and had success with some exits. And off that success we were able to close on our inaugural fund at the beginning of last year, we raised an institutional back fund of $210 million, which allows us to swing a lot higher than our fund weight.

Jon Van Tuin (02:28):
So, think of us as a $400 million plus fund doing control deals, founder-led, family-own businesses for the most part. Typically, these are companies with 3 to 25 million dollars of EBITDA and we tend to focus from a high perspective on manufacturing industrial growth or industrial technologies and then business services or kind of tech-enabled business services. We do have an area that we focus on from a thematic perspective that we feel like we can add a lot of value. We've got 15 people on the team, 6 of those people come from a 20–30-year operating background within aerospace and defense. They're all part of the P4G team here. So, we feel like deals that are in kind of that sector, that space, we feel like we can add a lot of value cut to the chase really quickly on opportunities and get to a closing fairly quickly at evaluation that makes sense for a seller. So, I would say, you know, from an operations perspective, we tend to focus the group a little more operationally than a lot of other private equity groups, particularly in the aerospace and defense area.

Jonathan Gilbert (03:39):
Oh, that's great. Well, again it sounds very exciting that at P4G and sounds like some great things on the horizon and whatnot. You know, for today's topic, one of the things that we wanted to, you know, chat about a little bit was the supply chain risk and how firms like P4G look to manage that supply chain risk with their portfolio companies. You know, certainly, you have a diverse group of companies in a variety of industries, including aerospace, industrial as you mentioned and others, you know, we hear our portfolio companies are having a little bit of better time with supply chain. Certainly, prices may not have come down as much, but it doesn't seem as bad as it was, you know, a year ago. Talk to us a little bit about, you know, the challenges that your companies have faced in the last year, and you know, where things kind of stand today and how you see supply chain going forward, and then what may have changed, you know, how companies adapted from how they approach supply chain, you know, pre-COVID.

Jon Van Tuin (04:35):
Yeah, so fortunately we haven't had much, even during COVID with supply chain challenges, there has been some given that we just raised our inaugural fund. We've kind of been building out our platform. So, we've done four transactions, one outside of the fund that was a legacy investment called UEI, our unique elevator interiors. That was done prior to the fundraising. We've done three subsequent platform investments over the last, I'd say 18 months since closing on the fund. And you know, knock on wood here, we haven't seen a lot of challenges within the supply chain for us, I think one of the things that we had seen earlier on that's kind of worked its way through the system is we are tier one supplier on a couple of our platform investments that are in the aerospace and defense sector and waiting on components from some of our OEMs that we're dependent on in terms of having to manufacture a product based on a product that they're supposed to send us, had slowed up the supply chain. But I would say over the last three or four months, we've seen that kind of work its way through the supply chain.

Jon Van Tuin (05:46):
So, luckily, we haven't really kind of been impacted as much. We do have, as I said, an operational focus and we tried to build redundancy into our supply chain, and I think a lot of people have realized that maybe they didn't have enough redundancy during COVID. Kind of as the water went out, so to speak, people realized that redundancy needed to be built into the supply chain. So, we've seen a lot of reinsuring back on in terms of your supply chain initiatives and actually that's one of our kind of thematic areas that we're investing in from a manufacturing industrial growth perspective and the sectors that we're focusing on and kind of thematically rethinking and investing in businesses that are reinsuring.

Jonathan Gilbert (06:28):
That's great. It makes a lot of sense and I imagine that you know, one of the value adds for your firm is having that in-house expertise from an operational standpoint that could really help your portfolio companies through any challenges that exist as you guys have been there, done that.

Jon Van Tuin (06:44):
Yeah, absolutely. I think those go, I know, a long way with sellers that we talk to, not only upfront when we're trying to sell a deal and get a deal across the finish line and hopefully be the preferred buyer in those transactions, but also obviously once we're in a deal from a portfolio perspective, really kind of being able to add value, roll up our sleeves and kind of build out a particular platform.

Jonathan Gilbert (07:08):
That's great. Thanks for that and very insightful. Let's shift Jon, if it's okay with you, kind of, just general M&A market activity, on your outlook for 2023.

Jon Van Tuin (07:19):
Yeah, yeah, sure. It's really been an interesting year so to speak given that we came off of 2021, obviously a record year for everybody in terms of M&A activity last year. This year, I mean if you read various trade magazines, you know, M&A activity is down anywhere from 10% to 25% in terms of just number of deals getting completed. We really haven't seen the volume drop off at P4G. What we have seen is just the quality of deals relative to last year. So last year we saw a lot of A-companies kind of pulled forward for a lot of reasons, whether that was potential tax law changes, kind of macro headwinds just coming out of COVID. A lot of entrepreneurs kind of threw up their hands looking to sell their business. I wanted to go through another crisis kind of what was next after the great financial crisis and COVID.

Jon Van Tuin (08:12):
So, we've seen just the quality of deal flow be down a little this year. So, a lot more B/C type businesses. I think, you know, what kind of continues to drive the M&A market is just the overhang of private capital out there both from a debt and equity perspective. And next year is going to be really interesting. We all know kind of the macro headwinds that are facing the market from rising interest rates, supply chain challenges. We have seen lenders pull back here in the last quarter, last three months in terms of leverage. And that is starting to impact the M&A market, particularly in those B and C deals or those deals that tend to cycle with the economy. We're seeing groups both from a lender and a private equity perspective give a lot more thought and pause on valuation and structure on those deals that cycle with the economy.

Jon Van Tuin (09:02):
But we're also seeing those companies that are, I would say those A-type assets that are "the unicorns" in our space that have all the qualities that you look for, are still trading at premium valuations, valuations similar to what was getting done at the back half of 2021. And so, you know, heading into 2023, I'm still pretty positive on the market depending on how aggressive the Fed gets. Even more so from where we're at today, as I mentioned, we are seeing lenders pull back and a couple of things I think is kind of driving that as we head into the end of the year. A lot of groups on the lending side and private equity have kind of hit their numbers for the year. And so, some are pulling back, but some are also cautious of kind of what's ahead of us in 2023 from a macro perspective. I think both of those are kind of impacting kind of the M&A activity right now. So, 2023 is really going to be dependent because the capital overhang is really not going away. It's really going to be dependent on how many sellers decide to come to market and if there's a clearing price that can be met between buyer and seller in 2023.

Jonathan Gilbert (10:15):
That's great. Very insightful. And yeah, we're also you know, pretty optimistic on 2023. Some say we have a bit of a biased view given that, you know, it's certainly, what drives our business is M&A activity and so we have a pretty positive outlook. We've also been very active. It doesn't feel like a slowdown on our end, so it's sort of an interesting time for sure, and we'll see what happens in 2023.

Jon Van Tuin (10:40):
Yeah, the lower middle market, middle market M&A is very resilient. You know, very different from the public markets that we read about every day in the paper. Probably a big reason why LPs continue to flock to alternative assets, particularly in the private equity, private capital space in terms of, you know, supporting those type of companies.

Jonathan Gilbert (11:01):
Yeah, that's interesting. And you know, just to go off script even a little bit more, I mean, one thing that, you know, Alliant's working to do is to work with a, you know, 401K provider to actually give certain individual investors as part of 401K plans, an opportunity to invest in private equity firms. So, it's going to be an interesting thing to see how more and more people have access to alternative investments, including private equity firms. How do you see that landscape changing from, you know, what was a very small group 20 years ago to what's expanded today and then really does private equity firm investments ever get to the masses like it is in the stock market or mutual fund?

Jon Van Tuin (11:40):
Yeah, I mean, you know, when I first got into the industry back in the late eighties, private equity was a cottage industry and you know, deals got done by handshakes and you know, you knew a guy Joe, who had a friend over at the country club that owned a business. He didn't know what to do with it. And you got introduced to the guy and the next thing you knew you had a handshake deal, 90 days later you owned a business. And at that time, it was about, you know, you were paying five, six times for a business and basically leveraging the company up and really didn't have to focus on growing the business, really paying down debt. And you got a 30% ROI. Today, obviously that market has completely changed for private equity. It's now about adding value to your portfolio companies. Obviously, that's going to continue here going forward and as more capital kind of continues to come into private equity. I do not see that tapering off in any way, in terms of just the amount of capital flowing into private equity, both from a debt perspective and the equity perspective. Those will continue to drive valuations and as long as private equity continues to outperform the S&P500, you'll continue to see allocators of capital continue to invest in the alternative asset space of private equity.

Jonathan Gilbert (12:59):
Yeah, that's great and that makes a lot of sense as well. And I think there's only going to be more and more private equity firms and capital in this space, as you said as well, for years to come. You know, shifting to your point on, you know, things have changed and I've only been in the industry serving private equity firms since 2004. Certainly, we've seen diligence evolve quite a bit, you know, from what it was from my perspective, you know, 10, 15, 20 years ago. And one of those areas that we've seen a substantial uptick in is, you know, companies pre-close work around cyber security diligence, trying to understand the four walls of the network and how secure that is or not, and does the company have the right pieces. How important is sort of cybersecurity as you guys think about perspective investment or in looking at the portfolio itself?

Jon Van Tuin (13:47):
Yeah, it's definitely gotten a lot of attention, not only kind of from a macro perspective, but within private equity and, you know, certain industries, obviously, we have a higher kind of antenna in terms of that being important within companies, whether you're investing in FinTech consumer-facing businesses where data is very important within our portfolio. You know, we invest a lot in aerospace and defense because of the sensitive information. Cyber is extremely important in those businesses. And so, as you mentioned, this whole third-party diligence, there's been a whole industry that's kind of grown up around private equity that didn't exist when I first got into private equity. And the diligence process has become extremely extensive in terms of all the third-party providers that are now involved in getting a deal across the finish line. And it can be like you know, kind of juggling a lot of balls in the air trying to get a deal done.

Jon Van Tuin (14:42):
But, you know, I think the big reason for that is deals. Because the M&A market in private equity has become such more an efficient market in terms of all the processes that are now typically a seller uses through a sell-side process, that all the deals are now priced to perfection. And so, buyers want to make sure that the asset that they're acquiring is what they're paying for. And so, it's an intensive process and important reason for sellers to have a representative on the other side of the table that can kind of hold their hand and walk them through a lot of the diligence and the intensity of that diligence that a private equity brings to bear on a transaction because most sellers aren't prepared for it if they haven't done this process before.

Jonathan Gilbert (15:31):
Yeah, that's a very interesting point. You know, if the evaluation doesn't allow for certain risk areas or risk tolerance, then yeah, certainly the level of diligence would increase. I didn't think of it that way, but that makes perfect sense. Well, shifting back to kind of P4G and your overall strategy. You know, another trend that we've seen over the years is just an acceleration in add-on acquisitions by our clients one platform and it could be 1 to 20 sort of bolt-ons. How important is add-on acquisitions to your strategy at P4G?

Jon Van Tuin (16:05):
Yeah, it's very important. You know, we have a couple of growth strategies that we typically deploy within a portfolio company. Usually comes down to either organic growth strategy or add-on acquisitions or both. And, you know, add-on acquisitions have become extremely important for most private equity funds here and kind of driving alpha within the portfolio, particularly in industries that are highly fragmented, that you can scale through acquisitions and get synergies out of the acquisitions. It just makes sense. And I would say typically, you know, we're averaging at least three add-ons per platform. If I look back historically within our portfolio, and there's certain platform investments that lend to an add-on strategy more than others. And so typically with an add-on strategy, those investments can take a little longer to play out just simply because you can't create acquisitions and pull them off a tree versus an organic growth initiative.

Jon Van Tuin (17:05):
So, it just really kind of depends on the platform investment. But add-on acquisitions, I mean, you know, 6, 7, 8 years ago you couldn't give away an HVAC or plumbing, residential plumbing business to a private equity fund, and all of a sudden, they figured out it's a fragmented market. And look, we can go out and acquire these mom-and-pop businesses and put it together and, you know, acquire them for six, sell them for north of 12 times EBITDA, and that's what's kind of played out here and you see that in a lot of other kinds of industries across the country.

Jonathan Gilbert (17:36):
That's great. That's very helpful. Someone said that we're in the great resignation period right now where employees are very mobile and there's a lot of opportunity to move around. Can you talk to us a little bit about how your companies have been affected by anything related to labor, whether it's increasing wages or retaining good talent, you know, how do you sort of look at that? What have you seen in the portfolio the last year?

Jon Van Tuin (18:00):
Yeah, so it's definitely been a challenge not only within our portfolio but just among my peers that I talked to, you know, retaining talent, finding talent. Because at the end of the day, one of the things that I've kind of learned over my career is really, it's not the product or the service that the company does, but at the end of the day, it's people that are going to make an investment successful and finding the right people and investing in those people I found is kind of what has led to successful deals over the course of my career. And what we typically look for in a lot of our portfolio companies or companies that we're looking at to acquire, is that they have some sort of either training program, educational program, for example, a lot of the A and B companies that we invest in.
It's really hard to find people that can work on CNC machine equipment. It's been a dying profession. And so, we look for companies that have in-house training, educational programs, certifications, whether that be welders, things like that, that basically allows an individual to build a career path and training within an organization that allows them to gain a skill set that hopefully adds value to the business, adds value to the individual, and allows them to progress throughout the organization. So very important for us to have companies that we're investing in where they have kind of thought that out, have some sort of training, recruiting program that has been effective in terms of bringing talent into the organization.

Jonathan Gilbert (19:40):
Nope, that makes a lot of sense, and then certainly let's hope for active market next year and rational sellers for sure. Thank you again, appreciate your time and look forward to talking further and thanks everyone that listened in as well. If you'd like more information on Alliant, please visit us at www.alliant.com. Thank you and have a good day.